There was much brave talk Tuesday when the Federal Reserve effectively cut interest rates to zero. One radio reporter said the central bank saw this as “an opportunity” to take proactive steps against the recession. Wall Street rallied. Yet the reality is that the Fed is very afraid.

Despite the hurried $700 billion bailout passed by Congress and as much as $2 trillion in largely secretive “facilities” the Fed has made available to lending institutions and who know what else, the economy is in free fall.

Credit markets remain seized up. More than 1.9 million jobs have been lost this year, punctuated by November’s sudden acceleration of 533,000. These numbers significantly undercount the real situation, leaving out those who have given up looking for work — say, in the bleeding banking sector — or the underemployed.

Fed Chairman Ben Bernanke, who is one of the leading scholars of Fed policy during the Great Depression, is most fearful of deflation, which is now a serious danger. Deflation was one of the defining reasons why the Depression was so deep and prolonged. Back then, the smartest monetary policy makers believed the budget must be balanced and interest rates increased.

Ooops.

Although Bernanke is determined not to repeat that mistake, it’s unclear how much he can do to avoid the reckoning that I call the Great Disruption. Many of today’s best and brightest are similarly befuddled by today’s unique challenges.

Fed limited.

The Fed is limited in its ability to levitate an economy that has collapsed. To quote Alan Greenspan from a mild recession in 1991, “You can’t push a string.” In extremis, the central bank can, as Bernanke memorably said, drop shrink-wrapped pallets of dollars out of helicopters. In other words, inflate the currency. Bernanke apparently believes he can get away with it. Inflation has been tame lately. Unfortunately that is almost entirely a function of falling energy prices, itself an ominous signal of anticipated demand destruction by severe recession — and traders desperately unwinding their futures contracts to get liquidity. Also, the recent inflation numbers are backward-looking. The vast expansion of the money supply may be baking a severe inflation in the cake. This possibility could also unnerve the foreign lenders upon which the United States now depends.

Yet even zero interest rates may not resusitate the economy. Japan’s central bank took similar steps after the Japanese real-estate bubble burst in the late 1980s, and the country still endured a recession that lasted more than a decade. Nor can the Fed create value from “toxic assets” that are in fact derivatives composed of nothing tangible. In many cases they are mere swindles, little more brazen than the $50 billion Ponzi scheme alleged to have been cooked up by Bernard Madoff, one of the lions of Wall Street.

Finally, one must approach the Fed’s action with skepticism because of the way the central bank and Treasury Secretary Henry Paulson have managed the crisis so far. After denying the gravity of the problem for months, the two panicked lawmakers into passing a “rescue” that independent auditors agree lacks direction or proper oversight. Lehman Brothers and Washington Mutual were allowed to fail, while Paulson’s alma mater Goldman Sachs was propped up and AIG was notoriously thrown taxpayer money. And all, so far, to little effect except for continues big compensation for the big cheeses.

The immediate rally from the rate-cut may well be just a pump-and-dump on a grand scale, as the big traders try to make a day or two’s gain from one of the stock market’s two drivers, greed. The other, fear, will kick in soon enough. Consider how many wealthy individuals and institutions are willing to get zero gain in exchange for the security of Treasury notes.

The problems behind the current unpleasantness were years in the making. Among them:

deregulation;

a hollowed out manufacturing economy replaced by one based on fraud and house-building;

stagnant wages for most Americans;

over-consolidation of industries;

Fed-generated market bubbles;

and income inequality not seen since the eve of the last depression.

The larger issues of the Great Disruption, particularly peak oil and climate change, have yet to be addressed.

As long as policy-makers keep trying to save that which is unsustainable we won’t even have begun the long path to recovery.